Federal Reserve decides to hold interest rates steady

WASHINGTON -- The Federal Reserve, keeping a close eye on the fragile, postwar economy, held a key interest rate steady at a 41-year low Tuesday. But policy-makers opened the door to a possible rate reduction in the future in the event that business conditions take a turn for the worse.

Fed chairman Alan Greenspan and his Federal Open Market Committee colleagues opted for now to keep the federal funds rate at 1.25 percent. The funds rate is the interest banks charge each other on overnight loans and is the Fed's primary tool for influencing economic activity.

However, the Fed sent a signal that its stands ready to lower rates.

The Fed identified the greatest risk facing the economy as a further weakening in economic activity. This stance positions the central bank to reduce the funds rate in an effort to bolster economic growth should the economy show signs of backsliding, economists said. The Fed's next meeting is June 24-25.

"The committee believes that ... the balance of risks to achieving its goals is weighted mainly toward weakness over the foreseeable future," the Fed said.

At the Fed's previous meeting on March 18, policy-makers said that given all the uncertainties surrounding the Iraq situation at that time, they could not gauge risks on the economy going forward -- something they normally do at each meeting.

Tuesday's vote was unanimous.

On Wall Street, the Dow Jones industrial average was up 76 points in trading after the afternoon Fed announcement.

Holding the funds rate steady means that commercial banks' prime lending rate-- the benchmark for many consumer loans -- will also remain at 4.25 percent, the lowest level since May 1959.

Both the funds rate and the prime rate, which move in lockstep, were pushed down to their currently low levels on Nov. 6. That marked the Fed's first rate cut of 2002 and its 12th since January of 2001, when the central bank began an aggressive rate-reduction campaign in a bid to rescue a seriously distressed economy.

Lynn Reaser, chief economist at Banc of America Capital Management, said that how the economy shapes up between now and the Fed's next meeting in June will largely determine whether rates remain at their current levels or are moved lower.

"If the economy starts to look stronger, the Fed will remain on hold. But if we don't see an improvement they will likely cut rates," she said.

Tuesday's Fed decision comes as the postwar economy is struggling to get back on firmer footing.

The end of the war in Iraq hasn't produced an economic boom -- as some had hoped.

Consumers' confidence in the economy -- which had sunk under war worries -- rebounded in April, an encouraging sign.

But businesses -- still not feeling unsure about the strength of economy's recovery -- are wary of big investments in capital spending and in hiring. That's a major factor hurting the economy's ability to get back to full speed.

While the weak state of manufacturing and rising unemployment is disappointing, the Fed said that "the ebbing of geopolitical tensions has rolled back oil prices, bolstered consumer confidence and strengthened debt and equity prices."

The Fed said that these developments, along with currently low interest rates, "should foster an improving economic climate over time."

Still, the Fed said that the "timing and extent of that improvement remain uncertain."

The Fed also expressed concerns about deflation-- a prolonged bout of falling prices. "The probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level," Fed policy-makers said.

President Bush, mindful of the political price his father paid in 1992 for a weak economy, wants Congress to approve another round of tax cuts that he argues would help bolster economic growth and create jobs.

The nation's unemployment rate jumped to 6 percent in April as businesses cut jobs for the third straight month. The economy has lost one-half million jobs in the last three months, a decline usually associated with recessions.

The worsening job climate is troubling because it could make consumers -- the main force keeping the economy going -- more cautious, economists say.

Some economists believe the jobless rate will creep higher -- to around 6.3 percent to 6.5 percent later this year -- even if the economy improves a bit. Job growth probably won't be strong enough to accommodate all the additional job seekers who would enter the market, attracted by an improved climate, economists said.

The economy grew at a tepid rate of 1.6 percent in the first three months of 2003. Economists see more subpar growth in the current quarter, with estimates ranging from around a 1.8 percent rate to a 2.5 percent rate. In the third quarter, economists are expecting a growth rate of 3 percent or higher, an improvement but still below normal.

Greenspan last week expressed cautious optimism about the economy's prospects now that the war is over. He said the economy is "positioned to expand at a noticeably better pace," but the timing and the extent of that improvement remain uncertain.

In addition to the rebound in consumer confidence, there have been some other encouraging signs. Energy prices, which had risen sharply on war tensions, have recently retreated and the rollercoaster stock market has stabilized.

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